Preparing businesses for director incapacity in the UK

Directors play a crucial role in making key decisions and guiding a company towards its objectives. If a director of a company becomes incapacitated without adequate preparation, it can lead to significant disruptions in the governance of the business, stall critical decision-making processes and cause uncertainty for shareholders.

Understanding the challenge

Inadequate planning can also cause legal and operational challenges, making it difficult to keep the company operating in compliance with applicable laws while maintaining the confidence of shareholders, employees, and customers. The incapacitation of a director not only affects the individual and their family, but can also have far-reaching consequences for the company's stability and future prospects.

In this article we consider specifically a director's mental incapacity – their inability to make decisions. For example, entering a coma, developing dementia or similar unfortunate circumstances. These are distinct from situations where a director may be incapacitated for physical health reasons (e.g. undergoing chemotherapy) but they still have decision-making capacity. In such situations it may be more appropriate for the relevant director to simply appoint an alternate director in their stead (which they can revoke when they are fit). 

The core issues

When a director is unable to act due to incapacity, they cannot perform their duties, delegate their powers, or appoint anyone else in their stead (assuming the company's articles of association permit this). The situation becomes particularly dire if the incapacitated individual is the sole director, as the company would then be effectively unable to function until a new director is appointed.

In cases where there are multiple directors, the company must assess whether it can still meet the required number of directors for its decision-making. If it cannot, the company is effectively paralysed. Even if that number can be met, it may not always be an appropriate commercial outcome. For instance, in a joint venture (JV) where each party appoints a director, an incapacitated director could allow one party to make decisions unilaterally, thus undermining the JV's balance. 

Similarly, in the context of family investment vehicles, incapacity could prevent a family branch from participating in decisions, disrupting the intended governance structure and broader family harmony.

If the incapacitated director is also a shareholder, or controls a shareholding entity, then suddenly the most obvious route to replace a director (by decision of a company's shareholders) may be unavailable without an appropriate power of attorney in place. Replacing the director would then quickly become a complex legal ordeal, requiring court intervention which is both costly and time-consuming.

Strategies for mitigation

Fortunately, there are a number of measures available to safeguard against these risks, including:

• ensuring that companies' appointing shareholders (or, in the case of family investment companies, family members) have a mechanism to replace their representative directors swiftly and efficiently upon incapacity.
• verifying that shareholders – particularly if they are also directors or if the director represents a shareholder entity – have a lasting power of attorney in place. This legal document would enable their attorney to exercise their shareholder rights to vote on director changes without delay.
• appointing additional directors who can ensure that a quorum is always met, even if one director becomes incapacitated. Shareholders' agreements or company's articles of association can be tailored to allow an appointed director to have additional votes where one such director is incapacitated in order to maintain balance in decision-making, particularly in commercial JVs.

Any of these – and several other options – can be tailored to the circumstances of the relevant directors through appropriate legal language.

Powers of attorney granted by a director over their office as a director (as opposed to their capacity as a shareholder) may not be effective – and therefore for certainty we recommend that one of the alternatives discussed here should be adopted instead.

Conclusion: proactive measures are key

Companies must proactively address the potential for director incapacity before it occurs. The articles of association of any company, and any shareholders' agreement (if there is one), should address the company's specific commercial situation. Additionally, shareholders who are also directors should have powers of attorney in place to ensure seamless transitions when necessary.

By taking appropriate steps, companies (and shareholders) can protect themselves from the operational and legal turmoil that can arise from a director's sudden incapacity. 

If you would like to discuss appropriate measures for your business, please contact the Withers Corporate team.